Understanding and Increasing Finance for Climate Adaptation in Developing Countries
Published: December, 2018
This report explores the current state of finance for climate adaptation and proposes practical, near term solutions to both fill in knowledge gaps and to increase investment. While many of the suggestions can also be applied in developed countries, which often face similar challenges in measuring and deploying adaptation finance, the focus of the report and selected examples highlight the role for developing country national governments and stakeholders, such as development finance institutions, local governments, and civil society organizations including academic institutions in supporting increased knowledge and investment in adaptation. The report benefits from discussions held during three adaptation finance focused workshops organized by CPI and adelphi in 2018 to present and discuss preliminary findings of this study.
There is an urgent need to spur greater investment into climate adaptation and resilience, in both the public and private sectors. The frequency and magnitude of natural hazards triggered by climate change has been increasing globally, leading to USD 1.5 trillion in economic damages from 2003 to 2013 (FAO, 2015), in addition to impacts to human and ecosystem health.
However, current investments in adaptation constitute only a fraction of what is needed to avoid costly and catastrophic future impacts. The costs of adaptation in developing countries could range from USD 140 billion to USD 300 billion per year by 2030 (UNEP 2016). At the global scale, costs are likely to be between USD 280 billion and USD 500 billion per year by 2050, with even higher costs possible under higher emissions scenarios (UNEP 2016). Despite the significant climate risks at hand, combined with countries’ efforts to implement policies that are conducive to scaling-up finance for climate change, investment in the sector has not taken off, with USD 22 billion of tracked global investment to address climate change going towards adaptation activities in 2016 (Oliver et al., 2018).
The measurement and disclosure of climate risk is the first step to developing strategies to address risk as part of all investment decisions. Regular assessment and disclosure also helps to measure the effectiveness of interventions over time.
In addition, tracking investment in adaptation and risk reduction is important to understand where investment is – and isn’t – happening. However, there is no standard format to report on climate finance (and thus adaptation finance) for developed and developing countries so far (UNFCCC, 2016), though countries can do so in their National Communications, Biennial Update Reports (BURs), and Nationally Determined Contributions (NDCs).
In addition, there is still little agreement on what qualifies as adaptation finance and how it should be measured (UNFCCC, 2016). Adaptation activities are project and location specific, and they respond to specific climate vulnerabilities. Unlike mitigation activities, it is not possible to produce a standalone list of adaptation activities that can be used in all circumstances as adaptation investment often involves mainstreaming resilience into all investment decisions. In addition, as climate resilience and adaptation are intrinsically linked to development, it is difficult to distinguish between a standard development project and a development project that contributes to climate change adaptation. Multilateral development banks have developed agreed upon tracking methodologies, resulting in the most comprehensive datasets available (MDBs, 2018, MDB-IDFC, 2018). However, these methodologies have not been widely adopted.
Furthermore, several barriers exist – relevant to both public and private investment – that are preventing or slowing the adoption of adaptation practices, services, and technologies at the scale that is needed, especially in developing countries (Hallmeyer and Tonkonogy, 2018). These include:
- Context barriers, which are specific to the market that is implementing the adaptation projects and related to the policy and institutional environment. This is particularly relevant for private capital, which is in part driven by the incentives generated by regulatory and policy frameworks. Gaps in these frameworks are frequently cited as constraining adaptation investments.
- Business model barriers, which are specific to the adaptation product or service being offered, and can include challenges such as: uncertainty around investment returns; lack of consideration of climate risk in investment decisions; high upfront costs of technology; and a lack of technical capacity to implement and maintain adaptation products.
- Internal capacity barriers, which can lead to a lack of companies offering adaptation products and services not operating at scale. The internal capacity of a product or service provider determines whether it is investment ready (Lieberman et al. 2015) and whether it has the capacity to expand to new geographies or sectors, especially in developing countries.
Many approaches have been proposed and/or implemented to address investment barriers in adaptation. They often focus on specific areas of risk management, for example increasing the availability and adoption of risk assessment tools, or providing financing for risk reduction or transfer. Solutions can be arranged into three groups, which can address the investment barriers described above.
- Increasing demand for climate adaptation services and products, such as through policy reforms that set rules for how businesses and government evaluate, disclose, and manage risk; funding market studies that describe the potential impacts of climate change for specific local geographic areas; and supporting product demonstrations.
- Sustaining suppliers of climate adaptation products and services to help them scale-up, such as through the development of technology and data standards that allow many actors to engage with each other in the climate risk market; and provision of data, such as basic weather and exposure data that are public goods which businesses can build upon to offer value added services.
- De-risking adaptation investment to address cost and information barriers, such as early-stage funding of new technologies before they are market-ready, and soft loans to infrastructure projects that add resilience into their designs at additional cost. This can also include direct investments into adaptation projects, particularly government assets.
The role of developing country governments
While many aspects are also of relevance for developed countries, we have identified the following suggestions for developing country governments to enhance understanding of adaptation finance and drive further investment into adaptation through improved tracking, public policy, and finance.
Supporting risk assessment and tracking efforts
Domestic public actors have the largest incentive to fill the gaps in measuring adaptation progress. This includes assessing risks, and measuring actions taken to reduce risk. In particular:
- Integrating adaptation within existing national planning and evaluation systems, which would help streamline workflow and generate ‘buy-in’ from those responsible.
- Countries could participate in discussions around disclosure of climate risks to investors, such as the TCFD, and where possible adopt best practices in measuring and disclosing climate risks.
- Finance ministries in developing countries could analyze the threat that climate risks might pose to their sovereign debt, and incorporate considerations regarding their mitigation as part of their strategy to ensure financial sustainability.
- Further efforts are needed to improve domestic public sector tracking practices, opting for an integration with existing national planning and evaluation systems.
- Governments could find ways to systematically incorporate national development banks at the margins of climate action into tracking initiatives to build a more complete picture of their international climate efforts. Donors, on the other hand, could support the process by continuing to address the need to develop harmonized approaches.
Actions to increase investment
Developing country governments will need to support a multitude of efforts to meet the adaptation goals and priorities outlined in their NDCs and other relevant strategies and plans. These include efforts that help increase demand for climate adaptation products and services that measure, reduce, and/or transfer climate risks; increase supply of these products in local markets; and de-risk adaptation investments using different policy and financial tools.
- Near-term opportunities for increasing demand for climate adaptation products and services include, among others, voluntary or mandatory disclosure requirements to investors; supporting market studies and technology demonstrations to improve the business case for adaptation products; and incorporating climate risk assessment requirements in infrastructure PPP contracts.
- Near-term opportunities for increasing the supply of climate adaptation products and services include, among others, improving the quality of and access to public data; supporting the local development of catastrophe risk models; and providing technical assistance and concessional equity to suppliers of adaptation products and services to better serve local markets.
- Near-term opportunities for de-risking investment in adaptation include, among others, supporting local utilities to issue resilient infrastructure bonds; adopting pay for success instruments to reduce under-performance risk of new adaptation technologies; participating in regional catastrophe risk insurance pools; and offering technical assistance and catalytic finance to climate smart agricultural lending and index insurance initiatives.
- adaptation finance
- climate finance
- climate investment
- climate policy
- developing economies
- financial innovation
- Nationally Determined Contributions (NDCs)